Buck Bullish: But Is It Bullish Enough?

This morning’s better than expected weekly US jobless claims report finally got the Bombed Out Buck to make a consequential move to the upside.

At 502,000 claims, this week’s print was both better than last week’s (514,000) and below the 4-week moving average (see chart below). What matters most to our macro model is what happens on the margin. On the margin, this is Buck Bullish!

Our risk management process takes one of 3 positions on a market: Bullish, Bearish, or Not Enough of one or the other.

Is this weekly claims report Bullish Enough to get the US Dollar to move above our immediate term TRADE line of $76.20?

We don’t think so. Not yet. Until we get comfortable with making a call that last month’s 10.2% unemployment rate was a cycle peak, I am not going to go there.

Employment is a lagging indicator. But this morning’s weekly print needs to be respected as a concurrent indicator. Ask those who are still short the US Dollar about that (we covered our short position in the USD a few days ago).

KM

Keith R. McCulloughChief Executive Officer

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11/12/09 09:00 AM EST

RETAIL FIRST LOOK: A CROSS-SECTION OF EARNINGS

RETAIL FIRST LOOK: A CROSS-SECTION OF EARNINGS

November 12, 2009

TODAY’S CALL OUT

On the whole, this morning’s earnings were positive coming in above expectations (and beyond recently pre-announced levels in the case of KSS). What’s interesting to note is the breadth of the read-through given the broad demographic cross section captured by WMT (discount), KSS (mid-tier), and URBN (fashion). Here’s our initial take:

WMT:

WMT came in a couple pennies above guidance ($0.84 vs. $0.78-$0.82); however, the focus will be on the deceleration of comps on a 2Yr basis reflecting domestic weakness. The company continues to drive its price leadership message, which in turn is driving traffic (up 1.5%), but is putting some pressure on the topline in the near-term. Results in 3Q and guidance for 4Q reflect a deceleration in same store sales on a 2-yr basis. Aside from self-driven pricing pressure, management also noted that food deflation continues to pressure sales and the impact was greater than expected in the quarter. Given the sheer amount of times “price leadership” was mentioned by management, we suspect Wal-Mart will remain aggressive over 4Q, implying that a meaningful pick up in traffic (i.e market share) will be necessary to see meaningful upside.

KSS:

While it might seem obvious given the majority of retailers are heading into the holiday season with clean inventory positions, KSS’ pattern of raising and beating expectations is likely to continue. Margin and sales comparisons are easing while at the same time the company reported its best sales/inventory ratio in a year. Recall, that the company is managing inventories well, even against a backdrop where they are opening new square footage at a rate greater than each of its competitors. Guidance implies another deceleration in two-year comps, but it just looks extremely conservative on the surface. Yes, the holiday is still uncertain but the set-up here looks to be one erring on the side of upside, both relative to the company’s forecast and the Street estimates.

URBN:

Incredibly tight inventories and significantly easing compares provide a meaningful tailwind over the next few quarters. Given the trajectory of URBN’s comps it appears the brand continues to gain traction, driven mostly by its cleaned up merchandising presentation (i.e less clearance/clutter/confusion) and fashion leadership at both Urban and Anthro. Offsetting this setup is of course high expectations given the steady improvement we have seen over the past few quarters.

LEVINE’S LOW DOWN

Some Notable Call Outs

Macy’s noted that its improvement in sales over the third quarter was prevalent across all regions. However, the Midwest region was the standout. Bloomingdales also outperformed its sales plans and was noted as having a “particularly strong” quarter. Management also commented that all three of the company’s Manhattan locations are showing improvement (after being hit particularly hard with tourism declines).

Add Blu-Ray discs to the list of items that are being heavily discounted at Wal-Mart, Best Buy, and Amazon. The aggressive pricing on new releases follows the footsteps of recently reduced prices on best selling books and standard definition DVD’s. The pricing on the Blu-Ray discs is expected to be $17, a substantial drop from the $25 average price for new releases.

Tuesday’s launch of video game, “Modern Warfare 2” is on track to be the biggest video game launch ever, eclipsing last year’s launch of Grand Theft Auto 4. It is believed that Modern Warfare sold 7 million copies in the first 24 hours, and is on track to sell 10 million by the end of its first week. At the suggested retail price of $60, that would mean “gamers” spent $600 million in one week on the new release!

MORNING NEWS

KKR Puts Higher Valuation on Dollar General Than Walmart in IPO - KKR & Co., the private-equity firm that bought Dollar General Corp. just before the leverage buyout boom collapsed, is taking the discount retailer public at a higher price than investors pay for Wal-Mart Stores Inc. KKR, Goldman Sachs Group Inc. and other owners plan to sell 34.1 million shares of Dollar General today, according to data compiled by Bloomberg, less than 2 1/2 years after purchasing the Goodlettsville, Tennessee-based company for $7.3 billion. The $784 million sale, which would be the largest initial public offering by a U.S. retailer in at least 17 years, values the discount merchant at as much as 29.5 times earnings, Bloomberg data show. That’s almost twice as expensive as the 15.4 multiple for Walmart, the world’s biggest retailer. <bloomberg.com>

Geithner Sees ‘Early Signs’ of Economic Rebalancing - U.S. Treasury Secretary Timothy Geithner said there are “early signs” that the world is addressing imbalances in spending and saving that contributed to the global crisis. Asia is “leading the world” back to recovery, Geithner told reporters in a joint press briefing with counterparts from the Asia-Pacific Economic Cooperation group following a meeting in Singapore today. American exports are also growing at a healthier rate, he said. APEC finance ministers today echoed calls by policy makers around the world for reduced reliance on Asian savings and American spending, a pattern that analysts say held down U.S. borrowing costs and fueled a credit bubble. In a joint statement, they also reiterated a pledge to maintain stimulus efforts “until a durable recovery in private demand is secured.” Geithner said that while it’s too soon to withdraw stimulus measures, the Obama administration is committed to reducing the record U.S. fiscal deficit, a legacy of reliance on overseas funds and unprecedented stimulus spending to counter the crisis. <bloomberg.com>

K-Swiss Announces $70 Million Stock Buyback Program - K-Swiss Inc. announced its Board of Directors authorized a new stock repurchase program for the company to repurchase up to $70 million of the company's Class A Common Stock. This program replaces the Company's existing 2004 stock repurchase authorization for up to 5,000,000 shares that expires on December 31, 2009. Under the new stock repurchase program, the company may purchase through December 31, 2014, as market conditions warrant and from time to time on the open market or otherwise, up to $70 million of its Class A Common Stock. The company believes the repurchase of its shares of Class A Common Stock can be a good use of excess cash depending on the Company's array of alternatives. Since August 1996, the company has expended an aggregate of $166.8 million through its several stock repurchase programs by which it has purchased 25.5 million shares of its Class A Common Stock. <sportsonesource.com>

Fed Officials Say Recovery Will Be Hampered by Unemployment - The U.S. economy will be slow to recover from the deepest recession since the 1930s as rising unemployment curbs consumer spending, Federal Reserve officials said. San Francisco Fed Bank President Janet Yellen raised the prospect of a “jobless recovery” in a speech in Phoenix, while Dennis Lockhart, who heads the Atlanta Fed, predicted a “relatively subdued pace of growth” this quarter and beyond. The comments yesterday are among the first on the economic outlook since the Fed signaled last week that a return to growth alone won’t be enough to change its policy of keeping interest rates near zero for “an extended period.” Instead, the central bank said any change would depend on increases in employment and inflation. <bloomberg.com>

Walmart Adjusts Asda Ownership - In Asda's most recent annual reports, the retailer discloses that Walmart has "sold" Asda to Corinth, another Walmart company, for a £5.7 billion ($9.4 billion) cash payment and £1.24 billion ($2.05 billion) in shares. Asda directors have been appointed to Corinth's board. Where Corinth was a subsidiary of Asda, it is now the parent company. Asda reports the deal had been done for good financial management reasons. Asda's annual accounts also revealed the supermarket chain paid £111 million ($184 million) in tax, down from the year before and that its profits before tax were £520.4 million ($862.1 million), also slightly down on 2007, on sales of £18.57 billion ($30.76 billion). The chain is third largest in the U.K. behind Tesco and Sainsbury. <licensemag.com>

Nike's Jordan Brand announces new AIR JORDAN 2010 shoe - A division of footwear, apparel, equipment and accessory products manufacturer NIKE Inc (NYSE:NKE), Jordan Brand announced the launch of its AIR JORDAN 2010 shoe on Wednesday, to celebrate its quarter-century of design and genre-inspiring style. AIR JORDAN 2010 will pay respect to the legacy of Michael Jordan in basketball and to the talented Team Jordan athletes in sports, with Dwyane Wade being the first to debut the shoe created by Jordan Brand. Air Jordan's footwear, apparel and accessories are inspired by the legacy, vision and direct involvement of Michael Jordan.

Study: Retail Shrink Rising - Worldwide retail losses from shoplifting, employee theft, organized crime and administrative errors jumped 5.9 percent to $114.8 billion for the year ended June 30, according to a new survey. The losses, known as shrink, represented 1.43 percent of sales of the 1,069 retailers that were surveyed in 41 countries. Total shrink in the U.S. rose to $45.99 billion, or 1.6 percent of sales, up from 1.48 percent a year earlier. Apparel retailers experienced the highest rate of theft — 1.84 percent of sales — of the categories tracked in the Centre for Retail Research’s third annual Global Retail Theft Barometer. The survey was sponsored by Checkpoint Systems Inc., a shrink management firm. <wwd.com>

Study Sees Higher Holiday Apparel Spending - A holiday miracle could be in the offing for apparel marketers, according to a new forecast by Brand Keys. Despite predictions of lackluster holiday business, 16,000 consumers responding late last month to the branding consultant’s annual survey expect to spend an average of 10 percent more for apparel than they did a year ago — a surprising leap, considering a projected 1 percent drop in outlays overall. After two years on the sidelines, these shoppers appear ready to add some new clothing to their wardrobes, including pieces to replace things that have worn out or no longer fit, said Robert Passikoff, president of Brand Keys. The holidays also may unleash seasonal demand for apparel, traditionally the number-one holiday gift, albeit one overshadowed in recent years by demand for gift cards and electronics. <wwd.com>

Macy’s Upbeat on Holiday Season - Macy’s, the nation’s biggest department store chain and an industry bellwether, cut its losses in the third quarter and now has a brighter outlook on the holiday season. Executives, in a surprisingly upbeat mood despite the nation’s rising unemployment and economic uncertainties, said the new view stems from a recent uptick in mall traffic; strong sales of private labels, exclusive merchandise and online; better business at Bloomingdale’s; lower inventories overall, and the My Macy’s localization program. However, the retailer’s shares fell Wednesday after its fourth-quarter profit projection was below Wall Street’s expectations. <wwd.com>

Target takes aim at mobile holiday shoppers - Target Corp. is adding new mobile features for the upcoming holiday season. Due to launch next week, Target will offer shoppers access from their mobile phones to checklists, holiday planners, gift and video finders, and holiday-planning text alerts. On its mobile site, Target.com, Target allows shoppers to view, manage and update their TargetLists, which are lists that include items picked out by gift recipients. Later this month, shoppers will be able to access this feature on the Target App for iPhone. <internetretailer.com>

Westfield Reports Strongest U.K. Sales in 7 Years - Westfield Group, the world’s biggest owner of shopping malls by market value, said retail sales in October at centers in the U.K. have risen at the fastest pace in seven years. The rate of store closings has also fallen since the March quarter, Managing Director Steven Lowy said in a conference call today while providing an update on the Sydney-based company’s performance in the three months to Sept. 30. Westfield’s London shopping complex, which opened at the height of the global financial crisis last year, has attracted some 20 million visitors and has signed more than 15 new tenants, the mall owner said in a statement on its Web site in October. Retail sales in the U.K. rose 3.7 percent in the three months on a comparable basis, Westfield said. <bloomberg.com>

Safilo Tender Offer in Doubt - Italian eyewear firm Safilo Group SpA on Wednesday reported a $71.6 million third-quarter loss and cast doubt on its life-saving recapitalization deal with Hal Holding NV because of a weak response to the Dutch shareholder’s cash tender offer. Losses for the three months through Sept. 30, which included a 28 million euro, or $40.2 million, writedown of assets, widened to 50.1 million euros, or $71.6 million, from 6.7 million euros, or $10.1 million, in the year-ago period. As reported last month, sales declined 7 percent to 212.6 million euros, or $306.1 million. Dollar figures were converted at average exchange rates for the period. Safilo approved a recapitalization plan on Oct. 19, in which Amsterdam-listed Hal would inject new equity and pay off some of the eyewear maker’s debts in return for a stake of between 37.23 and 49.99 percent. <wwd.com>

Travel Retail Expands at LAX - Travel retail is set for expansion at Los Angeles International Airport as part of an at least $1.2 billion overhaul. Looking to the future despite a recession driven decline in tourism, officials last month approved a plan to double retail and restaurant space in the next four years to about 100,000 square feet at the Tom Bradley International Terminal. Visitors to the airport, which has nine terminals with a total of almost 185,300 square feet of retail concessions, will encounter changes well before the Bradley project is scheduled be finished in 2013. Four other terminals with 22 retail units and 27 food units occupying 71,145 square feet will be updated by 2011. Four more terminals are also scheduled for improvements before completion of the Bradley facilities. <wwd.com>

Overstock.com Succeeds in Goal of Raising $30,000 for Veterans - Overstock.com, Inc. (Nasdaq: OSTK) today gratefully thanked its customers for their overwhelming response to Overstock.com’s announced goal to raise $30,000 for Wounded Warrior Project by Veterans Day. "These are great Americans and great people, who served their country honorably," said Overstock.com Chairman and CEO Patrick Byrne. "Whether or not you agree with the conflicts in which our nation is engaged, this is an opportunity to give valuable assistance to true American heroes." <money.cnn.com>

Banana Republic Opens SoHo Prototype - On Wednesday, the upscale division of Gap Inc. unveiled the New York City version of its new store prototype at 552 Broadway between Prince and Spring Streets. The two-level, 18,000-square-foot store offers a series of “boutiques” off a main boulevard, each designed “like idealized walk-in closets,” the company said. F <wwd.com>

INSIDER TRANSACTION ACTIVITY:

WAG: Marilou Ferstel, Director, sold 4,100 shares for a gain of $162k.

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11/12/09 08:09 AM EST

Lessons From A Macro Man

“It was the sittin’ and the waitin’ that made me all the money.”-Jesse Livermore

Q: What famous short seller from Milwaukee used to spin vinyl at Yale Hockey parties in New Haven, Connecticut? A: Jim Chanos.

I was on a plane to Kansas City yesterday. I was equipped with my standard flight issue: helmet, gloves, and a pile of reading. After I removed the foil and put on my glasses, I was quite satisfied to see some Lessons From A Macro Man at the top of my pile.

In his most recent presentation at the Virginia Value Investor Conference (10/22/09), Jim Chanos outlined some “Lessons from the Financial Crisis That Investors Will Soon Forget.” Taking a cue from a man’s work that I have often appreciated from afar, I have marked some of the lessons down in my notebook.

*Full Disclosure: I have cherry picked the 3 lessons that are most closely aligned with the views that I tend to belabor:

1. “Too Big To Fail = Too Big To Exist”

2. “Capitalism on the Upside and Socialism on the Downside”

3. “Quantitative Easing Has a Cost”

While Chanos may not appreciate being called a Macro Man, that’s fine. I am certain he has been called worse. It’s better than being called Octopussy. What’s most interesting to me about the evolution of his investment thoughts is how closely his “bottoms up” conclusions are aligned with someone as “top down” as me.

Wall Street likes to put investors in boxes. They like to label us “value” guys and “macro” gals. Some fund of funds like to think that they really have this pinned down. Maybe that’s why they don’t. The best way to ensure that a groupthinker doesn’t think outside the box is to draw one around his head.

To borrow a thought coined by my neuroscience friend, Richard Peterson, “Inside The Investors Brain” can be a fascinating place to observe behavior. The New Reality is that great investors are evolving their investment processes. They always have. As the game changes, they do.

Macro matters. Three years ago a lot of investors disagreed with me on that. Everything is crystal clear in the rear-view. There has never been more real-time and interconnected macro data affecting market prices than what you see out there today. “There were 5 exabytes of information generated from the dawn of mankind to the year 2003… that amount of information is now generated every two days.” (Eric Schmidt, Chairman/CEO of Google).

So now that we are successfully bridging macro conclusions with what does and does not work in the American Financial System, I guess the only thing for us to do this morning is to get right back to work. No matter where you go this morning, here the new macro data points are.

Bullish US stock market factors:

1. The SP500 closed 1 point above its YTD high from October 19th – higher highs are bullish

2. The Nasdaq has moved back above its immediate term TRADE line of 2125

3. US market volatility (VIX) closed below its intermediate term TREND line of 24.91

Bearish US stock market factors:

1. The Nasdaq didn’t make a higher-YTD-high; neither did the Russell 2000

2. The Russell 2000 (small caps are a proxy for liquidity risk) remains below its immediate term TRADE line of 595

3. Volumes continue to decelerate as market prices accelerate to +62.4% above the March 9th low

3. Oil continues to trade in a Bullish Formation (Positive TRADE, TREND and TAIL), with TRADE line support at $77.56/barrel

Bearish Global Macro factors:

1. Japanese and South Korean equities were down again overnight and remain broken from both a TRADE and TREND perspective

2. Dr. Copper is putting in lower-highs, trading down to $2.98/lb after inventories on the LME hit a 6 month high this morning

3. Chinese, Brazilian, and Russian equities have not confirmed the higher-high close in the SP500 (all are trading at lower-highs)

Those are just some of the outputs of my multi-factor macro model. I go through the same paces every morning. No glory. Rinse and repeat.

Another major macro data point that might be more topical to Mr. Chanos this morning is related to another one of his Macro Lessons: “Mssrs. Glass and Steagall Were Right After all”…

This could be a larger Macro issue than Healthcare. Word from the big insider birds in Washington has it this morning that Paul Kanjorski’s office (D – Pennsylvania) created quite a stir on the eve of what is the anniversary of a major Macro repeal. If you didn’t know that American savers (depositors) finance Wall Street risk taking and compensation structures, now you know.

Today is the 10-year anniversary of Clinton/Greenspan repealing Glass-Steagall…

Reversing the lessons from the men who didn’t do Macro back then may very well make Macro Men and Women of us all. After all, Greenspan himself is now on the record saying, that there was a “flaw in the model that I perceived is the critical functioning structure that defines how the world works.”

Volcker, Chanos, McCullough – we have a Macro view that investment banking and prop trading should be separated from traditional lending and deposit businesses. I’ll speak for myself in welcoming all comers in this critical Macro debate.

My immediate term TRADE lines for the SP500 are now 1072 and 1111.

Best of luck out there today, KM

LONG ETFS

EWT – iShares Taiwan— With the introduction of “Panda Diplomacy” Taiwan has found itself growing closer to mainland China. Although the politics remain awkward, the business opportunities are massive and the private sector, now almost fully emerged from state dominance, has rushed to both service “the client” and to make capital investments there. With an export industry base heavily weighted towards technology and communications equipment, Taiwanese companies are in the right place at the right time to catch the wave of increased consumer spending spurred by Beijing’s massive stimulus package.XLU – SPDR Utilities— We bought low beta Utilities on discount on 10/20. TRADE and TREND bullish.

GLD – SPDR Gold — We bought back our long standing bullish position on gold on a down day on 9/14 with the threat of US centric stagflation heightening.

CYB – WisdomTree Dreyfus Chinese Yuan— The Yuan is a managed floating currency that trades inside a 0.5% band around the official PBOC mark versus a FX basket. Not quite pegged, not truly floating; the speculative interest in the Yuan/USD forward market has increased dramatically in recent years. We trade the ETN CYB to take exposure to this managed currency in a managed economy hoping to manage our risk as the stimulus led recovery in China dominates global trade.

TIP – iShares TIPS — The iShares etf, TIP, which is 90% invested in the inflation protected sector of the US Treasury Market currently offers a compelling yield. We believe that future inflation expectations are currently mispriced and that TIPS are a efficient way to own yield on an inflation protected basis, especially in the context of our re-flation thesis.

SHORT ETFS

EWY – iShares South Korea— South Korea has joined Japan in the ominous position of broken TREND and TRADE. This is not China or Taiwan. This is an early cycle economy that we want to be short against China/Taiwan.

XLI – SPDR Industrials— We shorted Industrials again on 11/9 on the up move as the US market made a lower-high. This is the best way for us to be short the hope of a V-shaped recovery.

EWU – iShares UK— Despite areas of improvement, broader fundamentals remain shaky in the UK: government debt continues to expand, leadership in critical positions lacks, and the country’s leverage to the banking sector remains glaringly negative. Q3 saw its GDP contract by -0.4%. Further bank stimulus and the BOE’s increase in its bond purchasing program suggest that this will not end well.

EWJ – iShares Japan — While a sweeping victory for the Democratic Party of Japan has ended over 50 years of rule by the LDP bringing some hope to voters; the new leadership appears, if anything, to have a less developed recovery plan than their predecessors. We view Japan as something of a Ponzi Economy -with a population maintaining very high savings rate whose nest eggs allow the government to borrow at ultra low interest levels in order to execute stimulus programs designed to encourage people to save less. This cycle of internal public debt accumulation (now hovering at close to 200% of GDP) is anchored to a vicious demographic curve that leaves the Japanese economy in the long-term position of a man treading water with a bowling ball in his hands.

FXB – CurrencyShares British Pound Sterling— The Pound is the only major currency that looks remotely as precarious as the US Dollar. We shorted the Pound into strength on 10/16.SHY – iShares 1-3 Year Treasury Bonds — If you pull up a three year chart of 2-Year Treasuries you'll see the massive macro Trend of interest rates starting to move in the opposite direction. We call this chart the "Queen Mary" and its new-found positive slope means that America's cost of capital will start to go up, implying that access to capital will tighten. Yields are going to continue to make higher-highs and higher lows until consensus gets realistic.

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11/11/09 03:51 PM EST

RESTARANTS – CHARTS OF THE WEEK

I know I just published this chart, but I wanted to use it to make a point about the Restaurant industry in general.

I’m always thinking about what could be the next leg to take restaurant stocks higher or lower. We are nearing the point where the cost save thesis will be totally played out and food inflation will return – see the chart on the CRB Foodstuffs Index – it’s bottomed and headed higher. One of the best ways to generate ALPHA in the restaurant industry is to find a disconnect between sales trends and margin trends. In the restaurant industry, the relationship between sales and margins is very clear. This is very evident when looking at CKE margins versus same-store sales, until very recently (3Q09). Since then, margins have moved higher despite the continued fall off in sales trends.

While I’m using CKE as a case study, it does not stand alone. As I see it, for CKE and many other restaurant companies forward earnings are at risk. Sales are declining and not likely to rebound until consumer confidence improves and job creation begins again. Food costs are headed higher and the cost savings game has played out.

Just something to think about! Do you get the idea that I’m not a fan of CKE Restaurants right now?

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11/11/09 01:18 PM EST

Chinese and Russian Loan Data

Research Edge Position:Long the Chinese Yuan via the etf CYB

“Going forward, we are gradually promoting liberalization of the exchange rate.”

–Ma Delun, Deputy Governor of the People’s Bank of China, November 10th, 2009

When Keith and Brian are out of the office, the responsibility of running the morning meeting gets passed to me. I’m not sure whether that makes me important or not so important, but it does lead to a different tone and nature to the meeting. I am focused on Macro 100% of the time, so my perspective is different than both Keith and Brian’s. In these morning meetings, I’m looking for important Macro data points from our Sector Heads. This morning our new, and as of yet unnamed, Financials Sector Head provided a few nuggets to feed my ravenous macro data point appetite.

The first related to Russia and the Russian Banking System. Sberbank, which accounts for 1/4 of Russian banking assets and a 1/3 of Russia’s banking capital, indicated that he believes that bad loan provisions will peak in H1 2010 at around 12 – 14%. The implication of this statement is that the Russian banking system is seeing a light at the end of the tunnel in terms of the credit crisis. While 12 – 14% bad loans is certainly nothing to dismiss, the idea that bad loan provisions may be peaking in the not so distant future is certainly positive for the Russian economy, especially when this news comes from a bank that extends 31% of all Russian loans.

Sberbank is relevant for many reasons, but primarily, as noted above, it is by far the largest consumer bank in Russia and in some communities is the only bank available. In total the bank has ~20,000 branches and ~265,000 employees. It is a pseudo public institution as the Bank of Russia, the Russian equivalent of the Fed, owns 60.2% of Sberbank’s voting shares, with the remaining shares in private hands.

The second data point related to China, and supports our call for an early 2010 slow down for The Client (Research Edge parlance for China). It appears that loans internally in China came in well below expectations for October. New yuan loans in China were reportedly at CNY253BN versus an expected amount of CNY370 – 380 in October, so a dramatic miss versus expectations. This was on the back of a data point from the South China Morning Post on October 12th, 2009 in which the four largest banks in China, Industrial and Commercial Bank of China, Bank of China, China Construction Bank, and Agricultural Bank of China, lent CY110BN in September which was the lowest monthly total for the year.

In aggregate, these are mixed data points: the Russians are starting to see a peak in bad loans, while the Chinese are seeing a slowdown in loans, which will be a key leading indicator in the coming quarters. Currently though, China continues to roar in the Year of the OX. The Chinese reported Industrial Production this morning that was up 16.1% y-o-y, the largest gain since March 2008. In addition, retail sales gained an annual 16.2% in October. While we have our eyes on the leading indicators, and a potential slow down in 2010, there should be no confusion that the Chinese economic is currently in high gear.

As it relates to the virtual portfolio, these recent economic data points have also led to a shift in the Bank of China’s view of on the yuan. Previously, the stated policy was to keep the yuan “stable”. The new policy, as articulated in a quarterly statement yesterday, is to set the yuan’s rate in a “proactive, controlled and gradual manner and based on international capital flows and movements in major currencies.” This change in stance is obviously bullish for the yuan.

Daryl G. JonesManaging Director

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11/11/09 10:24 AM EST

CKR – MARGINS ARE LEVITATING

Earlier today, CKR reported period 10 and fiscal 3Q 2010 same-store sales results. Comparable sales trends continued to decline on a 2-year average basis at both Hardee’s and Carl’s Jr. in period 10 and in Q3. Carl’s Jr.’s top-line performance continues to be extremely weak with period 10 and Q3 same-store sales -7% and -5.2%, respectively. On a 2-year average basis, these results represent a 155 bp sequential decline in period 10 and a 120 bp decline in the quarter.

Trends at Hardee’s have slowed as well, though not to the same magnitude as Carl’s Jr. Same-store sales declined 3.4% in period 10 and -1.8% in Q3 with 2-year average results declining 75 bps on a sequential basis from period 9 and 55 bps from Q2. CEO Andrew Puzder again attributed the sales weakness to high unemployment and escalating industry discounting.

CKR also issued Q3 restaurant level margin guidance of 18% to 18.3%, implying 10 to 40 bps of YOY improvement. With blended same-store sales down 5.4% in the quarter, margin growth is impressive, particularly with depreciation expense as a percentage of sales expected to increase 80 bps YOY as a result of the company’s ongoing remodel program.

Lower food and packaging costs, which are forecast to decline 165 to 175 bps YOY as a percentage of sales, are helping to support margins in this tough sales environment. After Q3, CKR only has one more quarter of relatively easy food cost comparisons. In 4Q09, food costs as a percentage of sales were flat, but turned more favorable on a YOY basis in 1Q10 (down 60 bps). As this YOY food cost benefit moderates going forward, it will be increasingly more difficult for the company to maintain restaurant level margins with the current trajectory of sales trends. The first chart below shows how margins have continued to grow on a YOY basis despite the significant fall off in comparable sales trends (3Q10 YOY margin growth estimate reflects management’s 18%-18.3% restaurant level margin guidance). This is not sustainable. Positive sales growth will be needed to maintain margin growth trends.

Prior to Q3, lower YOY labor expense had helped to support margin growth for the last six quarters. This, too, was an unsustainable trend without eventual damage to the overall customer experience. To that end, I think it is encouraging that management is guiding to a 100 to 110 bp YOY increase in labor and employee benefit costs as a percentage of sales in Q3.

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